Oil has been outgunning tech in 2021 … long-term decline, but short-term gains … how to play it
The last few years have been brutal for oil investors.
To illustrate, take the Energy Select Sector SPDR Fund ETF (XLE). It holds oil heavyweights including Exxon, Chevron, ConocoPhillips, Schlumberger, Occidental, and Valero to name a few.
Below we compare XLE with the S&P from the beginning of 2015 through the end of last year.
In short, while the S&P made its investors 82%, XLE didn’t just lag behind … it destroyed 39% of investors’ wealth.
This underperformance is even more brutal in light of what your money could have been making.
Below, we show the same chart, but add in XLK, which is the SPDR Technology Select ETF. Its largest holdings include some of the biggest tech-winners of the last 12 months — Apple, Microsoft, NVIDIA, PayPal, and Salesforce.com to name a few.
While, as just noted, XLE has lost 39% over our highlighted period, XLK soared 245%.
This painful bleed for oil investors culminated in a fiery crash last April.
As you’ll remember, in early March, a disagreement between Saudi Arabia and Russia about oil production led the Saudis to flood the market with crude. Meanwhile, a world on lockdown due to the Coronavirus kneecapped demand.
The combination of oversupply and under-demand resulted in the price of oil plummeting. By late-April, it had fallen roughly 75% in 2020.
And then, history was made …
In April, the May contract of West Texas Intermediate (WTI) oil dropped below zero for the first time ever. On April 20, the price of a barrel of WTI ended at negative $37.63.
***But in the last few months, something interesting has been happening
Oil is back from the grave, and is now trading above its pre-pandemic prices.
Below, you can see the price of WTI trading at $60.06 a barrel, as I write Friday morning. One year ago, it was at $53.29.
I think you’ll find the chart below even more interesting …
In it, we return to the comparison between XLE (the energy ETF), the S&P, and XLK (the technology ETF). Only this time, we look at what’s been happening in 2021.
XLE is dominating.
It’s up 22% on the year, while the S&P and XLK have climbed just 5%.
Sure, it’s been less than two months, but this outperformance actually dates back to the fall.
Below, you can see XLE’s returns tripling those of XLK since late October.
***So, what does this mean? Is big oil back?
Yes and no.
Long-term, our world is moving toward renewable energy. And this transition is already manifesting in meaningful ways.
For example, in 2020, for the first time ever, renewable energy surpassed fossil fuels in providing European electricity.
Europeans got more of their electricity from renewable sources than fossil fuels for the first time last year, according to an annual report from Ember and Agora Energiewende.
The report, which has been tracking EU’s power sector since 2015, found that renewables delivered 38% of electricity last year, compared to 37% delivered by fossil fuels.
The shift comes as other sources, such as wind and solar power, have risen in the European Union. Both sources have nearly doubled since 2015, and as of last year accounted for one-fifth of electricity generation in EU countries, the report found. It’s also the reason why coal power declined 20% last year, making up only 13% of electricity generated in Europe.
Closer to home, President Biden has been pushing an aggressive agenda that has renewable energy at its center.
From JoeBiden.com (stating Biden’s goals as president):
Make a historic investment in clean energy and innovation. Biden will invest $400 billion over ten years, as one part of a broad mobilization of public investment, in clean energy and innovation.
That investment is twice the investment of the Apollo program which put a man on the moon, in today’s dollars.
CNBC goes on to note that the Biden administration plans to make the U.S. a 100% clean energy economy with net-zero emissions by 2050.
There’s a lot of time between now and 2050 for a profitable oil trade.
***There’s still enormous demand for oil — especially when the world economy reopens this year
Renewables have been enjoying tremendous growth in recent years, but the reality is that, globally, fossil fuels accounted for 84% of the world’s primary energy consumption in 2019.
Now, that number took a hit last year. Looking at oil specifically, the International Energy Agency (IEA) estimates that oil demand will have declined 9% when the final numbers are in.
But we’d be foolish not to recognize this decline for what it was — a world on lockdown due to the pandemic. As always, what’s more important for investors is what’s coming next.
On that note, here’s The Wall Street Journal:
The recovery in global oil demand will accelerate in the second half of this year as the market continues to rebalance after the turmoil brought by the pandemic, according to OPEC and the International Energy Agency.
Despite increasing its estimates for oil output in 2021, the IEA said in its monthly market report that a recovery in demand would outstrip production in the second half of the year, prompting “a rapid stock draw” of the glut of crude that has built up since the pandemic began.
The agency significantly increased its forecast for producing nations outside of the pact between the Organization of the Petroleum Exporting Countries and allies such as Russia, raising its projections for non-OPEC supply growth by 290,000 barrels a day to an increase of 830,000 barrels a day this year.
***If we look at the condition of the U.S. oil complex, we’re seeing a time-worn boom/bust pattern play out
It begins with good times … high demand and strong prices lure more companies into a sector … companies take on too much leverage as they ramp up production, trying to capitalize on the high demand … this leads to oversupply and falling prices … perhaps there’s an exogenous shock that further roils the market and leads to even lower prices … many of the overleveraged companies can’t operate at the new market price … this leads to a wave of bankruptcies and decimation in the industry.
We certainly saw this last year. According to a Rystad analysis from law firm Haynes and Boone, more than 100 U.S. operators and service providers, with more than $102 billion in debt, went out of business.
However, like a fire blazing through an overgrown forest, these industry burnouts clear out the competitive landscape. This results in conditions that are ripe for growth for the remaining strong players, who are now leaner, faster, and more efficient.
From Financial Times, speaking specifically of shale oil companies:
… a more resilient industry is emerging from the ashes that aims to woo investors.
Like the reincarnated Chesapeake, it will be smaller — some analysts believe the sector will be reduced to just 10 dominant shale producers.
Production increases will be modest and financed from cash flow. And activity will focus on fewer prolific shale fields, mainly in Texas.
Oil operators that feared new U.S. president Joe Biden’s ambition to launch a green energy revolution would stymie the industry’s drilling and slow production growth, now promise to do both themselves.
***How you might play oil’s resurgence
If you’re looking to play oil, there’s XLE, which we profiled above.
If you’re looking for a more explosive investment, you could look to well-run companies such as Diamondback Energy (FANG). It’s up 170% since early November.
What you’re looking for is a healthy balance sheet, reasonable debt levels, and a low breakeven cost for oil.
If you’re thinking “cash flow” you could also look to a major, like Exxon (XOM).
Though Exxon has been disastrous for investors over the past several years, it’s still making lots of money — and giving it to its shareholders.
For example, the oil giant just had its ex-dividend date on February 9 (used for tracking who enjoys a dividend payment). Investors who made the cut are going to enjoy a whopping 6.8% yield (a quarterly payment of $0.87 per share). Compare that to the 10-year Treasury at 1.33%.
Whatever your investing preference, there’s money in the oil trade.
Big picture — this energy source is on the long-term decline, but it can still put a wad of cash in your pocket in the shorter-term.
Have a good evening,